Monday’s panic-filled session delivered a volatility super spike worth talking about. The CBOE Volatility Index, or VIX, soared 34.45% registering the 11th largest one-day percentage gain in its history.
Not enough to crack the top 10 mind you, but notable nonetheless. And it’s enough to open some opportunities in the popular SPDR S&P 500 ETF Trust (SPY).
For those otherwise unfamiliar, the VIX index reflects the implied volatility for options on the S&P 500. When fear is rampant and traders are bidding up option premiums in a mad dash for protection the VIX index lifts.
As with all measures of volatility, mean reversion is a dominant driver of the VIX’s behavior. Like a rubber band stretched to the limit, the VIX has a strong tendency of falling after a sharp rise or rising after a sharp decline.
The tricky part is the timing. Sometimes the resolution of the fear spike arrives swiftly, other times the panic persists for days before cooler heads prevail.
Avid traders of S&P 500 Index options or SPY ETF should embrace the occasional VIX spike like yesterday’s. These fear fests re-inflate option premiums allowing elevating profit potential for short option trades going forward. With the VIX index perched near 19, SPY ETF option premiums are now more expensive than they’ve been since early February.
Past instances of such a sharp upturn in the VIX usually deliver a short term rebound in the market. While I don’t doubt there may be some additional fallout over the ongoing Greek drama, the lofty position of the VIX coupled with the now sharply oversold SPY ETF make contrarian plays an interesting proposition.
Selling SPY bull put spreads is an easy way of setting yourself up to profit from an eventual decline in volatility along with a short-term rebound in SPY. Because SPY ETF options have inflated you can now go far out-of-the-money to establish a wide range of profit.
Sell the SPY Jul $198/$193 put spread for 50 cents or better. The reward is limited to the initial 50-cent credit and will be captured if the SPY ETF remains above $198 by July expiration.
The maximum risk is limited to the distance between strikes minus the net credit, or $4.50, and will be lost if the SPY ETF tumbles below $198 by expiration.
At the time of this writing Tyler Craig owned short option positions on SPY.
